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Massachusetts' Credit Clash With Big Banks

Financial reform isn't just a hot issue inside the Beltway. In Massachusetts, the nonprofit Greater Boston Interfaith Organization (GBIO) has successfully spurred the state to divest money from several large, familiar companies. That may be good news not just for concerned Bay State residents, but also for consumers everywhere.

Massachusetts has a usury law, prohibiting banks from charging more than 18% interest on credit card debt and other debt. But national banks don't have to respect that law, and many routinely charge higher rates. That's why the state will yank some $212 million from a Fidelity Investments money market fund that has deposits with Citigroup(NYSE: C), Wells Fargo(NYSE: WFC), and Bank of America(NYSE: BAC), all major credit-card lenders.

The opposing caseThe banks have their defense ready, and some of it makes sense. They argue that it would be complicated and inefficient to abide by different rules for each of the 50 states. Furthermore, Bank of America points out that 70% of its customers are being charged less than 15%. The bank explains that it has to charge high-risk customers high rates, to offset their higher rates of default.

I understand that higher risks call for higher rates. But let's remember that these are years of record-low interest rates, when many dividend-paying stocks easily top what your bank account pays you. While Bank of America is charging its riskiest customers more than 15%, it's offering a "Business Interest Maximizer" (italics mine) account that recently paid between 0.10% and 0.30%. Savings accounts for customers offered less than 1%, and in many cases less than 0.50%.

True, riskier customers may not deserve low interest rates because of their higher likelihood of defaulting. But credit card rates as high as 30% could make it even more likely that they default on their debt.

The big pictureThe GBIO hasn't been alone in its efforts. Hundreds of religious leaders from seven states have been pushing for an "Interest Rate Reduction Act" to limit consumer rates to 15%. A cap on interest rates for all credit card users sure seems like a good idea -- but I quibble with the way it's being done. Banks do need a spread between what they borrow at and what they lend at. We all need to profit.

But there are times in history when interest rates will be sky-high. In 1989, for example, the prime rate topped 11%. In 1981, it topped 20%! At such times, a 15% limit on consumer debt will make no sense. Banks will either lose money by the fistful, which won't be good for anyone, or they'll simply be unable to extend credit -- also not so good. It would be better to suggest a cap on the spread.

Take actionAs investors, we play a part in this situation. If you don't like the high rates charged by the banks mentioned above, you can let management know. Shareholders can even file proposals to change how companies do business.

Investors in these lenders profit when the banks charge sky-high rates. But if that business seems distasteful to you, there are other investments you can consider. Carmakers such as Ford(NYSE: F) and Toyota(NYSE: TM) are offering vehicles with low-interest-rate loans in an effort to bolster sales. For Ford, the results have been quite impressive; its stock more than tripled in the last year. Toyota's stock is depressed, but this is a great time to ponder whether the company's many problems will prove to be long-term, or whether this is a brief window of opportunity.

Meanwhile, make sure that your bank isn't socking you with interest rates of 20% or 30%. Interest that steep could compound your debt with alarming speed. If you'd like to learn how to deal with debt, or just want fascinating facts about that piece of plastic in your wallet, consult our credit collection.

What do you think of Massachusetts' decision? Would you like to see more restrictions on financial institutions? Let us know -- leave a comment below!

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Author

Selena Maranjian has been writing for the Fool since 1996 and covers basic investing and personal finance topics. She also prepares the Fool's syndicated newspaper column and has written or co-written a number of Fool books. For more financial and non-financial fare (as well as silly things), follow her on Twitter... Follow @SelenaMaranjian